Are regulatory interventions in financial markets delayed reactions to market failures, or can regulators pre-empt corporate misbehavior? Anecdotal evidence suggests that regulatory activity has a strong reactive component. History offers several prominent examples: The British Joint Stock Companies Act of 1844 followed widespread business failures and bankruptcies, the U.S. Securities Act of 1933 and the Securities Exchange Act of 1934 are often seen as a reaction to the Great Depression and the Kreuger Crash, and the China Securities Regulatory Commission (CSRC) was created in the wake of riots by disgruntled investors during the infamous Shenzhen 8.10 incident in 1992. More recently, the Sarbanes-Oxley Act of 2002 was passed amid corporate scandals like Enron, WorldCom, and Dynegy.
To empirically test such a crisis theory of regulation, we construct a time line of corporate scandals and regulation, spanning 26 countries over more than 200 years. We identify more than 2,000 episodes of corporate scandals in our global sample, with scandals occurring most frequently in the United States, the United Kingdom, and Japan. From 1800 to 1969, there are 4.2 (2.4) episodes of scandals (regulation) in any given year, but this number jumps to 33.1 (14.7) over the 1970 to 2015 period. Thus, frequent scandals and extensive regulation are a relatively recent phenomenon.
When we examine whether one time series is useful in forecasting the other, we find that both corporate misconduct and regulatory action are not isolated events, but come and go in waves. More to the point, corporate scandals act as antecedents to regulatory action but the relation also goes the other way. Scandals follow past attempts at regulatory reform. This finding prompts the question of how to break this cycle of scandals followed by bouts of regulatory activism followed by new scandals while keeping the long-term effects for the economy in mind. Even though we cannot answer this question, our results cast doubt on the effectiveness of regulatory action from a public interest view.